As growth slows, China cuts local govt debt costs to spur investment

The change comes after overwhelming demand saw recent local government bond issues massively oversubscribed, underscoring both their distorted pricing and the market's appetite for high-quality debt as Beijing relaxes monetary conditions.

Chinese regulators have cut the premium that local governments must pay to issue debt, sources with direct knowledge of the matter told Reuters on Tuesday, lowering their borrowing costs as Beijing hopes to kick start investments and shore up growth.

Advertising

The change comes after overwhelming demand saw recent local government bond issues massively oversubscribed, underscoring both their distorted pricing and the market’s appetite for high-quality debt as Beijing relaxes monetary conditions.

The sources said local governments would be able to issue bonds at a minimum spread of between 25 and 40 basis points over central government bonds of the same maturity. Previously, local governments were required to issue bonds with a minimum spread of 40 basis points over equivalent Chinese treasury bonds.

“The previous minimum spread did not reflect the market,” said a trader at an Asian bank based in Shanghai. She added that while some traders were initially confused by the rule change, it effectively means a reduction in the minimum spread to 25 basis points.

Advertising

Xinjiang, an autonomous region in northwest China, issued the first local government bonds of 2019 on Jan. 21, kicking off total local government bond issuance of 129.6 billion yuan ($19.22 billion) last week, according to Reuters’ calculations. A further 288.4 billion yuan worth of local government bonds are due to be issued this week.

The record pace of issuance of normal and special-purpose bonds means local governments will in just two weeks use up 30 percent of the total 2019 quota for new local government bond issuance approved by the State Council late last year.

The 1.39 trillion yuan quota includes 810 billion yuan worth of new special bond issuance and 580 billion worth of normal bond issuance. Unlike normal bonds used to fund deficits, special bonds are targeted for specific funding needs such as land development, and are excluded from official budgets.

Beijing has encouraged local governments to issue bonds in the face of a sharp slowdown in infrastructure investment, with a multi-year crackdown on speculative debt constraining some governments’ finances.

Analysts said that the quota could be raised if economic signals remain weak, and that local governments could be allowed to issue 2 trillion yuan in special-purpose bonds this year, up from 1.35 trillion yuan last year.

But demand has more than kept up with supply, suggesting in part that local governments have been forced to pay too much to issue debt. Three separate bonds issued by the Fujian provincial government last week were oversubscribed by more than 53 times, according to traders.

Bonds issued on Tuesday by the Jiangxi provincial government were priced at the new minimum spread of 25 basis points, but still had bid-to-cover ratios in the 20s and 30s.

The yield on the province’s 10-year local government bond was 3.38 percent, sources said, 25 basis points higher than the yield on benchmark 10-year Chinese treasury bonds on Tuesday. It was more than 30 times oversubscribed.
Interest in the bond issue was widespread, with both private and state-owned banks, insurance companies and brokerages lining up to buy, a dealer said.

More Explained

“Everyone knows that these bonds will be highly oversubscribed and there will ultimately be very few winning bids, so they load in,” said the dealer.

“There’s too much money, and nowhere to invest it,” said a Shanghai-based asset manager. A Shanghai-based senior trader said that from the point of view of banks, local government bonds had the same risk profile as Chinese treasury bonds – but due to “guidance” by regulators, yields are by definition higher, making them more attractive investments.

Local government bond issuance typically begins in March after quotas are approved at the National People’s Congress. But faced with a slowing economy, authorities have brought issuance forward this year to spur investment.
The early allocation of quotas will “help bolster economic growth in the near term by enabling regional and local governments to provide funding at an earlier stage to support infrastructure spending,” said Amanda Du, vice president and senior analyst at Moody’s, in a recent note.

Advertising

At least 23 Chinese provinces have cut their economic growth targets for this year as weaker domestic demand and a trade dispute with the United States weigh on growth.